Debt consolidation is a restructuring of your current debt(s). You negotiate new terms and, in most cases, your total monthly payment is reduced, and interest rates may be reduced or even eliminated. Make sure, though, that the debt consolidation loan’s interest rate is lower than the original interest rate, or you will end up paying more in the long term, even if your monthly payments are lower.
Here are three things you need to understand before you enter into a consolidation loan:
1. Even though your monthly payment may be lower, you may end up paying more in interest as these loans usually extend the time it takes to repay the debt.
2. If you haven't changed your spending habits, the lower payment may cause you to think that you can buy something else. Thus, you may end up in a worse position than you are now. Use the extra money you have from the lower payments to make extra principal payments on the consolidation loan so that you pay it off earlier.
3. Be careful about changing unsecured debt, like credit cards, to secured debt, like a home equity loan. If you find you can't pay the consolidation loan, the unsecured debt that may have been discharged in bankruptcy may now cause you to lose your home or another item used as collateral for the consolidation loan.
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